Thursday, October 30, 2014


You'll remember the basic logic from Economics 101 that decreasing demand for a product will cause the price to fall, assuming the supply of that product is relatively fixed.  Likewise, increasing demand will cause the price to rise.  On the other hand, increasing supply will cause the price to fall, assuming the demand for that product is relatively fixed.  Likewise, decreasing supply will cause the price to rise.

The same basic logic applies to U.S. Treasury bonds.  The announcement by the Fed that Quantitative Easing (QE) will end this month means the demand for bonds will decrease by $15 BILLION next month, which suggests that interest rates (the price of the product) will fall.

Then, the basic logic breaks down.  It has never happened that the Federal government was unable to sell all the bonds it wanted, because they simply raise the interest rate enough to entice more buyers.   The bad news is that paying increased interest expense is taking money out of taxpayers pockets.

So, who will take the place of the Fed to maintain demand for Treasury bonds and mortgage-backed-securities (MBS), to keep interest rates from rising too much?  Conveniently, one of the new banking requirements is increased holding of liquid securities, such as Treasury bonds and MBS.  This liquidity requirement is at least 30 days of operation held in highly liquid assets, and banks must be "mostly compliant" by year-end.

(At the same time, don't forget the supply of new Treasury bonds has fallen by two-thirds since the global financial crisis.  In other words, the Treasury doesn't have as many bonds to sell each month as they did when QE started.)

In mid-November, there is a meeting of the G-20 in Australia, which is likely to also require some increased liquidity requirement on banks worldwide, further fueling demand for U.S. Treasury bonds and MBS.  Isn't that convenient?

While the end of QE does frighten the stock market, it will pass.  Interest rates will not soar.  The world will not end. 

Wednesday, October 29, 2014

He Said -- She Said

There are at least 130 economic indicators each month, but there has never been a time when all 130 indicated the same condition of the economy.  Considering all the different organizations producing all these indicators using different methodologies, it should not be surprising, but it can be confusing.

For example, the latest report on durable goods disappointed with a 1.3% decrease, despite the fact it was expected to increase 0.5%.  This is a significant difference and could suggest a turning point in economic growth.  The same day, we learned that consumer confidence rose unexpectedly to 94.5, which is the highest level since 2007.  This could suggest a strengthening economy, since consumer spending is 67% of GDP.  So, what is a person to believe, with two economic indicators indicating different things?

One approach is to do a "deep dive" into the data, where you would find the durable goods number was skewed by the wildly volatile category of non-defense aircraft, which fell 16.1%.  The other categories were relatively as expected.  So, the drop in durable goods is not as alarming as it first appears.

Diving deeper into the consumer confidence, it is clearly dependent on two factors, i.e., the improving job market and falling gas prices.  Reverse either and the level of confidence will decrease.  One worrisome piece of data is that the percentage of people planning to buy a house dropped from 5.5% last year to 5.1% now.  So, the increase in consumer confidence is not a reassuring as it first appears.

Another approach to understanding conflict among the 130 economic indicators is to simply talk with your friendly neighborhood economist and ask for his/her "gut-feel" only.  If you ask for more than his/her gut-feel, grab a cup of coffee and sit down -- you'll be there awhile.

Saturday, October 25, 2014

The Joy of Spanking?

My father used to joke with other parents that the reason I was such a good student was because he would spank me every week, whether I needed it or no.  His logic was that it was good for a kid to be humbled ever so often.  Of course, he was joking!

But, I still think about that with respect to both the economy and the stock market.  Both need to be humbled ever so often.  Over the long run, a recession is good for the economy, and a correction is good for the stock market.  We're overdue for both!

The Index of Leading Economic Indicators (LEI) was released this week, and it was surprisingly strong.  There is still no recession in sight.  There are ten components to the LEI, and nine were up, especially bank lending.  (Some think the huge reserves generated by Quantitative Easing has finally overloaded bank balance sheets so much they HAVE to make loans.)  The only component that was down slightly was consumer expectations, which is not surprising, given the steady force-feeding of PIE (Putin, ISIS, and Ebola).

The stock market enjoyed a scary, brief 6% correction (which is technically not a correction at all), but the bulls seem to be in-charge once again.  As a kid enjoys the reprieve between spankings, I guess we shouldn't complain.

Wednesday, October 22, 2014

View From THE Vampire

The excellent Research Department of the once-excellent Goldman Sachs has released their latest projections.  Here is a sampling:

1.  The U.S. economy is the economic engine of the world again.   (Agreed!)
2.  Our economic recovery still has room to run.  (Agreed!)
3.  GDP growth next year was reduced to 3.1%, which is still good.
4.  Unemployment will end 2015 at only 5.4%, which would be great.
5.  Inflation this year & next year will remain less than 2%.  (Agreed!)
6.  Ten-year-Treasury yields will end this year at 3.0% and next at 3.5%.  (Disagree!)
7.  The S&P 500 will end this year at 2,050 and next year at 2,100.
8.  Gold will end this year at $1,050 but rise to $1,200 next year.  (It's about $1,240 now.)
9.  The dollar will continue to appreciate through next year.

I do wish they would discuss how long monetary policy can propel this country alone, with no help from fiscal policy.  However long that period is, it is getting shorter every day.

Monday, October 20, 2014

Don't Ask Me Why

Despite being born and raised in the South and despite being named to play "Uncle Remus" in an elementary play due to my strong southern accent, I have never considered myself to be a "southern boy" or "good ole boy" of any type.  But, it troubles me that employment data from the South is less clear than employment data from the rest of the country.

Generally speaking, the rate of unemployment has been dropping all across the country since 2009.  But, in the last six months or so, it has risen in three southern states, i.e., Georgia, Tennessee, and Louisiana.  The predictable political response from the three Republican governors was that the Democratic administration was "fudging the numbers" for political purposes.  Of course, that not only assumes set-for-life-bureaucrats will choose to become criminals but also begs the question of why fudge the numbers for those three states and not other states with Republican governors, such as Texas.

Digging deeper, the other employment indicators, such as new unemployment filings, home purchases corporate hiring, etc., don't support the higher unemployment rates in those three states.  The economy in each of those three states is definitely growing.  The most common belief is that the labor force participation rate is increasing.  In other words, people in those three states are now more optimistic about getting a job and returning to the labor force but at a faster rate than they are being hired or absorbed into the labor force.

Digging still deeper, the unemployment rate is a blend of two survey techniques, i.e., the payroll survey and the household survey.  Now, the payroll survey is based on payroll taxes paid, supplemented by phone calls.  That survey shows continued job growth and falling unemployment in those three states.  On the other hand, the household survey is conducted by calling random phone numbers and asking how many people in that household are looking for work or have jobs.  It is the household survey that is driving up the unemployment rate in those three states.

Does that mean the phone canvassers have called disreputable random numbers for six straight months?  That is a remote mathematical possibility -- very remote.  Or, does it mean that random households in those three states hate the government so much that they lie as a matter o f principle?  But, why only those three states?  I don't know . . . 

Friday, October 17, 2014

Bull and Bull Markets

One of the rumors on the Street is that the reason stocks have been falling so much in October is that hedge funds have generally done poorly this year, under-performing mutual funds.  Feeling some financial pressure as individuals, they took a look at the 20% of profits that they keep and decided to take all the profits they could right now and sit out the rest of the year in cash.  This is Bull!  Most of them don't have any investment profits to take 20% from.  Plus, any firm that lets investor's money sit in cash, while they charge annual fees of 2%, will see investors run away from them.

Another rumor is probably true.  The strong rise in the dollar over the summer was due to foreign demand for dollars.  In August alone, foreigners bought $25.7 billion in U.S. Treasuries and $52.1 billion in corporate bonds.  Since you cannot buy U.S. bonds of any type with Euros or Yen or anything else, they had to sell those currencies to buy dollars, creating a bull market for the dollar.

Rumors come with all degrees of truth but some smell worse than others.

Thursday, October 16, 2014

Asking the Unknowable

For well over a year, I've been writing that stock market corrections of 10% or more are perfectly normal in the short run and even healthy for the stock market in the long run.  I've also written that the longer we go between 10% corrections, the more likely it will be a 15% correction, and we are almost two years overdue for a correction.

I expect this correction still has legs to run.  (The S&P is down 8% at this point.  Small cap stocks are already down 11.6%)  This is a fairly normal correction, reflecting slowing global growth, not a global financial crisis.  The sky is NOT falling.  Buying opportunities are coming up!

Still, this correction is more interesting than a plain vanilla correction, because nobody knows the emotional impact of Ebola on investors.  Instead of a normal 10-15% correction, does the fear of Ebola guarantee the correction will be 15-20%.  Nobody knows, but it happened at a very unfortunate time, compounding a normal correction.

Since you don't have a choice, just enjoy the ride down, secure in the knowledge there will be a ride back up.

Tuesday, October 14, 2014

Facts vs. Fears

The United States is producing well over 200 thousand jobs each month.  ISIS!  The latest survey of small business shows the highest level of firms saying now is a good time to expand.  Putin!  Lending to business is up 6.3% over last year.  Ebola!  The stock market hasn't had a 10% correction in 31 months.  Worry!  Oil prices are falling, with gas falling under $3/gallon.  Fret!  The dollar is once again strong and getting stronger.  Oh, No!  The annual Federal budget deficit has dropped over 50%.  Anxiety!  There is absolutely no evidence of inflation on the horizon.  The End Is Near!  Manufacturing is up 4.1% over last year.  We're All Going To Die!  Interest rates will not be going up for at least another 6-12 months.  Is It Too Late To Attend Church?  Corporate earnings are now at the all-time high.  That's It -- SELL, SELL, SELL . . . After all, you can always review the facts later???

Sunday, October 12, 2014

$700 TRILLION Stent

Jim Fixx was never a great runner, but he was the father of the running movement during the 1970's and 1980's, with the release of his best-selling The Complete Book of Running.  Although he was a fairly good runner, with a lean runner's physique, he nonetheless dropped dead from a heart attack during a normal daily run in 1984.  He had one fatal weakness, i.e., his heart.

The world financial system in general and the U.S. financial system in particular have been steadily improving since the global financial crisis.  This has allowed our economy to turn around and grow significantly.  However, even though our economy is running well, there is one fatal weakness, i.e., derivatives.

But, there is reason to celebrate . . . cautiously.  The International Swaps and Derivatives Association (ISDA) has just agreed with the 18 major banks dominating 90% of the worldwide derivatives trade to give regulators the power to suspend contracts for 48 hours.  I know, I know . . . it doesn't sound like any big deal, and it may not be, but it just might give regulators enough time to hopefully preclude another collapse like Lehman Brothers in 2008, by temporarily de-linking the contracts from the institutions.

It is not a complete lifestyle change of diet and exercise.  It is just another stent in a weak heart, because it does nothing to shine sunlight on the level of contracts outstanding, nor who is holding what exposure to whom.  But, it is a welcome step in the right direction.  With it, the world of finance just got a little bit safer.

Q3 Column

My latest column for Inside Business has been published and can be found at: 

Unfortunately, the online edition does not contain the graph found in the newspaper edition.  Therefore, I encourage you to buy a copy.  It does make it easier to see the change in the velocity of money.    

Thursday, October 9, 2014

Muscle Imbalance

Most every person struggles with internal conflicts.  One of the most common is that conflict between mind and heart or between the rational and the emotional.  A common assumption is that one is good and the other is not-so-good.  Therefore, it logically follows that the good one should be strengthened and the not-so-good one weakened.

Believing the mind is just another muscle that demands continual exercise, I have searched for both more information and more understanding all my life.  If anything, that search is stronger now than at any point in my life.  Believing the heart was an overly-strong muscle already, the Army helped me greatly to compartmentalize, coarsen, and control the emotional side.  It has demanded little effort since then.

But muscle groups need to be in balance.

Yesterday, I visited a dying client.  He must have mere weeks left.  A big, strong guy before, I could lift him with one arm now.  With a booming voice before, I struggled to understand his gasps now.  I must say he has accepted and respected his fate with both courage and grace.  I salute him!

Having done it many times, I know what to do, from a financial standpoint, after he is gone.  As is common, the kids suspect the trusted financial advisor is there to somehow cheat them of their inheritance, but I know how to educate them, while reassuring the widow.  I know what to do for them.

Maybe, it is because I'm getting older or because I've seen so much death or because my emotional muscle group needs to go back into the Army, but the burden of sadness seems to be getting heavier.

One of the most important concepts to economists is that of "opportunity cost."  What else could be purchased with this money?  For example, the cost of a new aircraft carrier is not one billion dollars, but is two hospitals and one medical school.  The opportunity cost of watching talented people die and take that talent to the grave with them is a cost beyond measure.  Oddly, in ways I cannot explain, economics helps me to somehow carry the sadness.

Wednesday, October 8, 2014

272 Points

Yesterday, I was reading the weekly commentary of my favorite sage, old Wharton professor, Dr. Jeremy Siegel.  It was written last Friday, and it concluded "from a technical standpoint, the rebound in the Russell 2000 Index from its May bottom was encouraging, but it may retest these levels.  It is not certain that, despite today's (Friday's) strong payroll number, a short term correction is not at hand."

In other words, he was predicting a technical but only short term correction.  Then, I looked at CNBC to see the Dow was down 272 points and wished the good professor was here.  I'm sure he would remind us that 272 points when the Dow is near 17,000 is trivial, compared to the 272 points when the Dow was only 8,000 points in 2009.  Then, I expect he would remind us that periodic 5-10 percent corrections are actually good for the stock market in the long run.  Lastly, he would remind us that he expects the S&P to end the year at 2,050 at least, compared to 1,935 now or up 5.9%.

And, I would remind you that he was the singular most accurate forecaster last year, missing it by a mere two points!

Tuesday, October 7, 2014

Quarterly Column

Readers know I write a column for Inside Business, which I submitted yesterday.  Here is the opening:

The sensitivity of stock markets to geopolitical events varies over time.  Since the global financial crisis of 2008/9, our market has been extremely sensitive to them.  But, over the last quarter, we have seen more Russian aggression against the Ukraine, practically assuring another recession in both Russia and Europe.  A virtually unknown “JayVee” terrorist group has drawn us back into Iraq, and it even immortalized its own barbarism by publishing videos of their war crimes.  Of course, Asia is not immune to geopolitical unrest, drawing closer to another “Tiananmen Square” in Hong Kong, which will unleash even more trade sanctions.  And, the horror of Ebola suddenly popped up in America’s heartland, further rattling our faith in government.

Yet, the S&P 500 rose 0.6 percent, and the Dow rose 1.3 percent during Q3.  This decrease in sensitivity to geopolitical events is simply breathtaking!  

Friday, October 3, 2014

Supreme Help . . . Please!

The pundit class is upset because the Supreme Court has declined to review any cases on same-sex marriage for this upcoming term.  Lost in their consternation, nobody has noticed the Court did take up two cases on redistricting, which I believe is the source of all political evil and far more important than same-sex marriage.

First, they will review whether the new Alabama redistricting plan discriminates against African-Americans.  While that is certainly understandable, how about discrimination against political moderates who lose their voice when their districts are skewed either to the left or the right in order to protect some politician?

Second, they will review whether Arizona can take redistricting responsibility away from politicians and give it to an independent commission, as has been proposed in Virginia.  Politicians are opposed to this, as they will lose the ability to pick which areas get to vote for them.  They argue that redistricting is the people's business, which should be done by their elected officials.  This is no different than arguing that only the foxes can guard the chicken coup.

Progress in Washington cannot be achieved until moderates have a chance to return, which will take many years at best.  The Supreme Court could help . . . please!

Thursday, October 2, 2014

Just One More Scare ?

Yesterday's frightening drop in the stock market was just that -- just another frightening drop in the stock market.  Rejoice -- we've been needing a 5-10% drop for a long time now.  Such temporary drops are essential for the long-term health of the market.  In fact, small-cap stocks are already in correction territory, and it looks like mid-cap stocks are rolling over as well.  Good!

Some fear it is the "October Effect," thinking the market always drops during that month, which isn't true.  Since 1929, October has been an up-month 60% of the time.  But, it has been more frightening.  Since 1929, there have been 91 days when the market rose or fell more than 6% in one day, but 23 of those 91 days have been in October.  I think we are still traumatized by the Great Crash in October of 1929 and the Minor Crash in October of 1987, when the Dow dropped "only" twenty percent that day.

I think yesterday's drop reflected our knee-jerk horror of an Ebola pandemic in the United States.  No question, that would be horrific, but we are not exactly defenseless against it.  Would it hurt the economy?  Absolutely . . . for awhile!  Would it crush the stock market?  Yes . . . for awhile!

If anything, the failure of the Dallas hospital to connect the dots only makes it less likely to happen again in the future.  I remain much more concerned about the Russia/Europe problem than the ISIS problem, or the Secret Service problem, or even the Ebola problem.  My darkest fear remains a financial collapse from derivatives, and that has nothing to do with Ebola!

Wednesday, October 1, 2014

Interesting Projections From Goldman

Analysts who work for firms that sell stocks are often called "sell-side" analysts.  Not surprising, they always have stock they recommend that YOU buy.  Investment managers are usually "buy-side" analysts and are bearish as often as bullish.  Normally, you listen to buy-side analysts and take sell-side analysts more lightly.

Goldman Sachs is both a seller of stocks, as well as an investment manager.  They tend to be bullish but can also turn bearish.  And, I do respect their investment research during both the ups and the downs in the stock market.

Their latest projections are this:

1.  They have studied recoveries in 13 developed nations since 1970 and have found that recoveries from housing busts are longer and slower than other recoveries.  Therefore, this anemic recovery which is now 62 months long still has plenty of recovery left in it.

2.  This is a jaw-dropper here -- the Euro will fall to parity, or equal one Euro for each dollar, by the end of 2017.  Companies that sell to the Eurozone will become un-competitive price-wise, but it will get cheaper for Americans to vacation in Europe.  That should also bring a good deal of investment dollars into the U.S. from abroad, which is good for the stock market.

3.  The tendency to think the sky will fall when the Fed starts raising interest rates is misplaced.  "Equity returns initially stagnate over the first few months of a policy-rate-hike cycle . . . then quickly resume their upward trejectory."  And, those interest rate increases are not expected until 2015.

4.  The unemployment rate will fall to 5.4% by the end of next year.

5.  Inflation remains modest through the end of 2015.

6.  The S&P 500 will end this year at 2,050.  It is about 1,955 now.

7.  Commodities like gold and oil will continue to trend lower, primarily to the strengthening dollar.

So, does that make Goldman Sachs a bear or a bull or a . . . just another "vampire squid," as they were described in Rolling Stone magazine?

Ripples In The Maternity Pond ?

Wouldn't it be great if all young people got a college education, along with the resulting good job, and then got married and bought  a home?  That was the notion when Congress greatly expanded lending to college students in the 1990's.   As we encouraged them to do, they promptly went to college, mostly brand-new, for-profit private "colleges" and received semi-useless degrees, which got them no job or an unexpectedly low-level job.  College debt now exceeds all credit card debt.  As I've written before, the heavy college debt makes them unqualified for the now-stricter mortgage approvals, and that is hurting home sales, which also prevents your home from rising in value more rapidly.

But, there is another perspective.  There has been "a massive new study" finding that, of the 9 million women who were in their early 20's during the Great Recession, about 151 thousand of them will defer having babies until they are at least age 40.  The stated reason for this is "economic insecurity," but I cannot help wondering how much of that insecurity results from the burdensome college debt we encouraged them to take.

One can argue that the best of intentions in the 1990's will result in 151,000 fewer Americans.